It’s no secret that the recession of 2008-2009 tested captive finance firms as well as their parent companies. Surrounded by a trio of challenges that included continuing to support long-term customers, guarding parent-company balance sheets and putting out portfolio fires, captives must have felt they were trying to tame a three-headed beast set on sinking its teeth into every captive-parent duo in the equipment finance industry.

But amid the chaos, the Great Recession spawned opportunity. Captives and parents came together in its wake to review the captive mission and reset strategy for doing business in the post-recession economy. Today, as a result, relationships between many captive equipment finance firms and their parent companies are stronger and closer than ever.

Eyes Wide Open

Lessons have been learned on both sides. Manufacturers now know that if they don’t offer product financing, their competitors will — sending sales into a tailspin as customers form new relationships with firms willing to give them the terms they seek. Manufacturers also understand that, given the chance, their captives can be creative, crafting financing products that take advantage of new opportunities, such as the financing of storage space and services in “the cloud.”

Even as the recession further recedes, captives aren’t standing idly by. They’re scrutinizing their value propositions, searching for holes through which competitors can squeeze. It’s no longer enough simply to provide financing; they must also deliver speedy turnaround, a single point of contact and an impressive amount of product expertise. Many captives are also driving efficiencies to maintain or improve their profitability and customer experiences.

A good example is a major U.S. captive now reporting annual growth of 15% to 20%, compared to 0% growth during the recession. The firm’s adrenalin comes not from bulking up its sales force or giving management the boot, but from a continual quest for efficiency that led to hiring additional customer service representatives and other lower-level personnel. To that end, roughly 75% of attendees at a recent roundtable of captive-company executives indicated that they, too, intend to hire in 2013 — but will likely limit those hires to lower-level positions. Said one executive, “If we do hire feet on the street, they’d better come trained — and with a big book of business.”

Not only are captives keeping a sharp eye on their own bottom lines; they’re also protecting parent-company assets by spreading the risk of financing. Increasingly, captives are turning to financing partners to provide funding. The case of one large manufacturer illustrates why: Over time, the firm financed so much of its sales on its own books that rating agencies began to look askance at the mounting debt and downgraded the company’s credit rating. Today this manufacturer is faced with a debt load that continues to climb and a stock price that is stumbling. Were the company to leverage outside financing sources, its problems might be solved.

Most true captives in business today support themselves. At one end of the spectrum are firms that exist solely to generate sales for the parent company. These captives typically pay for themselves but don’t necessarily turn a profit. At the opposite end of the range are stand-alone captives that not only pay for themselves, but prosper and pay dividends to the parent company. In the middle are captives looking to make a profit, but expected mainly to pay for themselves while providing financial products that help their parent companies sell product.

Developing Markets

Today, firms in all three categories are moving forward. Captives now own the lion’s share of new equipment-finance business originated outside the U.S. Were we to exclude international transactions financed by GE Capital, we’d see that more than 85% of the international volume reported by Monitor 100 companies for 2012 belongs to captives. U.S. banks and independents, by comparison, own less than 10% of this global new-business volume, according to Monitor data, and non-U.S. banks own the rest.

Fitch Ratings recently confirmed that captive finance subsidiaries of major global manufacturers continue to experience “very strong profit margins,” driven by “outstanding credit-loss performance and improved demand for their parents’ products.” Fitch acknowledged that captives and their parents have benefited from “excellent access to wholesale capital markets” that has allowed them to diversify and strengthen their funding profiles. New sources of funding have also allowed captives to term out debt maturities while increasing liquidity buffers in order to lower refinancing risk and support additional portfolio growth, Fitch said.

Fitch also noted that balance-sheet leverage at captives remains below five-year averages, which, given record low credit losses and expected moderation in portfolio growth, could result in increased dividends to parents. To that end, GE Capital, which has been much in the news lately, announced that it plans to return $6.5 billion in dividends this year to parent company General Electric.

Banks’ Bugaboos

But few trends last forever, and analysts at Fitch believe captives’ portfolio growth and credit-quality gains will moderate as competition with banks heats up. Even if this is so, however, the current skew in the financial landscape isn’t likely to reverse itself quickly. U.S. banks are afloat with liquidity but still struggling with post-recessionary regulation. Not only must the biggest banks expend enormous resources on regulatory compliance; they must also avoid transactions deemed by regulators to be too “risky” and thus, subject to penalties. A recent KPMG survey of 100 retail bank executives listed the cost of, and compliance with, new laws as executives’ number-one concern. More than one-third of bankers surveyed said navigating major changes in the regulatory environment would consume more time, energy and resources than any other project, and nearly 75% said that regulatory and legislative pressures constituted the largest barriers to bank growth.

Domestic regional and community banks, meanwhile, have spied opportunities left on the table by their larger brethren and are now entering the equipment-financing business at a steady rate. But many of these smaller banks are industry newcomers, unlikely to have the expertise necessary for assigning proper residuals and setting competitive prices. Others are likely to set residuals too high, making end-of-term equipment buy-outs suspect. Thus it’s not unreasonable to think that customers financing equipment directly through one of these institutions rather than through a captive could miss out on important benefits that captives provide.

True, banks don’t usually provide wholesale financing for equipment dealers. Nor do they as a class possess great equipment expertise or access to low-cost equipment remarketing. Independents, meanwhile, have either become banks, gone out of business or are now regrouping and gathering strength. Thus, captives may not have the lowest prices — but they have other advantages that are helping to grow their market share.

If additional information from Fitch is correct, the price gap between financing offered by captives and banks isn’t that large anymore, anyway. The financial rating agency noted that most captives reported robust origination trends throughout 2012 and during the first quarter of 2013 “as access to low-cost funding remained good” and demand for parent products accelerated. Automobile captives, including Ford Credit and General Motors Financial, are enjoying climbing demand for new vehicles as well as a strengthening auto ABS (asset-backed securities) market. At the same time, major equipment captives such as Caterpillar Financial Services and John Deere Capital are seeing strong portfolio growth as increased demand in the U.S. and Asia offset continuing soft markets in Europe.

Outside Efficiencies

In much the same way they’re working more closely with parent companies, captive finance firms are also placing new emphasis on relationships with administrative and financing partners. It’s a win-win situation: the more each entity knows about its partners’ missions, strategies and goals, the more efficiencies can be realized at either end.

Captives’ trend to outsource finance administration to their funding partners is an example. Executives at a number of captives now partnering with banks say their firms outsource some or all of their finance administration to funding partners. Other captives report outsourcing at least a portion of their administrative functions to third-party service providers. Bank of the West, DeLage Landen and GreatAmerica Leasing are among the companies providing servicing for captives, and they’re making inroads.

Thus it seems certain that for captives wanting to remain successful, outsourcing administration and gaining other efficiencies is a way to continue making money — especially if underwriting terms relax amid heightened competition, and used-equipment prices deteriorate as we hurtle toward 2014.

But there are always unknowns to consider, future market gyrations being just one. Another is the possibility that U.S. regulators will extend stricter government oversight to large non-bank financial firms. Treasury Secretary Jacob Lew was scheduled to appear before the Senate Banking Committee in late May to discuss the work of federal regulators implementing Dodd-Frank changes at banks. Observers are now waiting to learn if the Committee’s Financial Stability Oversight Council will also vote to subject certain nonbank financial firms to higher capital requirements and other rules, due to potential risks they may pose to the nation’s financial system. Regulators haven’t divulged the names of any firms being considered, but The Wall Street Journal reported that three firms (Prudential Financial, GE Capital and American International Group) have reached the final stage of a three-stage review.

Unknowns notwithstanding, however, most captive finance firms today are doing exactly what they should be doing: focusing on intrinsic advantages and taking control of opportunities as they arise.

Paul W. Frechette is senior managing director, Diversified Industries, for The Alta Group, where he focuses on strategic and financial planning, tactical execution, quality controls, organizational leadership and hands-on client development on a global basis. Prior to joining Alta, he was executive vice president at EverBank Commercial Finance, responsible for growth of its vendor finance business. His background also includes the position of corporate vice president and COO of Sun Microsystems Global Financial Services; president of Key Equipment Finance’s commercial leasing services group, and corporate management positions with Heller Financial, Fleet Credit and U.S. Leasing International.